Don’t go public! (?)

23 December 2015

A guest article by Bruce MacEwen, president of US-based Adam Smith, Esq.

Listing: public markets are far more forgiving

It has become a commonplace – I have bowed to convention and endorsed the notion myself – to observe that law firms are labour-, not capital-, intensive, and that (here’s the dangerous and subtle segue) therefore there would be no benefit to them in taking on outside investors, much less going public.

This is often combined, at least by the more nuanced, with a brief observation on the perils of law firms’ taking on a material amount, or any amount, of debt.

But what if the conventional wisdom is mistaken?

I’m put in mind of this by a recent technology State of the Artcolumn in the New York Times questioning whether Silicon Valley’s now long-running disenchantment with IPOs in particular and being public in general is actually mistaken.

While floating an IPO was once seen as a rite of passage in Silicon Valley, in the last few years it has become a much-bemoaned annoyance to many tech founders. Companies are waiting longer to go public, and thanks to a surge of money from hedge funds and mutual funds looking to get in on the start-up scene, young companies have been given resources to stay private for years on end.

Farhad Manjoo (the reporter) hooks his column on the recent much derided IPO of Box, the cloud storage company, whose stock is down about 40% since its flotation this past January. But contrary to conventional wisdom, Box seems delighted to be public.

“It’s great to be public,” said Aaron Levie, Box’s chief executive and co-founder, citing the unpredictability of the private funding market. “We don’t have to worry about any of that right now.” While some tech founders are concerned that public companies have to report earnings every quarter, spurring short-term thinking, Mr Levie said, “the three-month timeline allows you to create a strong internal rhythm of hitting your goals and accomplishing what you set out to do”.

Not only that, but publicly traded stock is a currency with which to make acquisitions or recruit key employees. Bill Gurley, the Benchmark Capital general partner and by any measure a top dealmaker in the Valley (Dropbox, Snapchat, Instagram, Uber), has come around to the same view. The Wall Street Journal asked him whether there was a recognition that eventually these companies have to go public so as “to get liquid”.

He replied: “I think that’s one of the biggest problems that we’ve had. There has been a mythos of stay private longer that I think is probably the worst advice that’s ever been given in Silicon Valley.

“The notion was that it’s hard being public, so why not just stay private as long as you can? I think it just allowed for more promotional behavior and less discipline and less recognition that eventually you’ve got to get to a place like a public market.”

Another Valley CEO you perhaps have heard of is also a convert. Mark Zuckerberg, who delayed Facebook’s entrance into the stock market for years, now believes that going public made the social network a better company. Facebook ramped up its mobile ad business as a result of pressure from public investors, who were initially sceptical of the company’s 2012 initial offering.

Facebook is now inching in on Google in the race to become the world’s largest mobile advertising company, and it’s hard not to credit the IPO for the zeal with which it staked out that position.

So far we’ve heard the operational reasons – increased discipline and strategic rigour, a sense of ‘rhythm’ imposed by quarterly reporting, and tradable/spendable ammunition in the form of stock. What about financial or balance sheet issues?

Here it gets particularly interesting for Law Land. Back to Bill Gurley (emphasis supplied):

“He argues that when businesses are hit with difficulties, public companies have more options for weathering the storm than their private counterparts do. The series of investments that make up a typical start-up’s fund-raising structure don’t do well in adversity, Mr. Gurley said.

“‘When growth slows, it gets complicated and expensive to raise any more money, and you hit this downward spiral,’ he said

“In contrast, public companies can withstand long spells of scepticism. Amazon, Apple, Google, Netflix and dozens of other tech companies have gone through fallow periods in which the world doubted their long-term prospects. Those times were painful, but as public companies each managed to survive the downturn. They weren’t wiped out by the doubts.”

If you don’t see where this is going, I have to ask if you’ve been paying attention to the last 10 years.

Law firms, dependent on the indulgence, trust, and faith of their partners for their capital contributions and the continuing forbearance of their bankers, can and have found themselves in a fatal liquidity squeeze faster than you can say “Dun your client now, I tell you!”

Relying on the mercies of others whose self-interest may suddenly be, shall we say, misaligned with the firm’s, is guaranteed to lead to tears. Particularly when those others are free to adopt very short-term time horizons.

By contrast, if firms relied on public markets for funding, the terms under which you can remain solvent as a going concern are far more forgiving.

Either way, organisations whose performance, over a long period of time and for the indefinitely foreseeable future, fundamentally absorb more resources than they throw off, will fail. As they should. But logic, experience, and corporate finance 101 all align in predicting that when the going gets tough, public organisations have a longer runway in front of them before investors can force a mandatory ‘lights out’ than do private ones.

Just a thought.

This article was first published on the Adam Smith, Esq. website. A lawyer and consultant to law firms on strategic and economic issues, Bruce MacEwen is president of Adam Smith, Esq., which provides management consulting services on the business and economics of law firms in a wide array of markets worldwide. Since the company’s launch in late 2003, nearly 1,500 articles have appeared on Adam Smith, Esq., covering such topics as strategy, leadership, globalisation, M&A, finance, compensation, cultural considerations, and partnership structures

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